Dec 4, 2014

Detroit Steers through Bankruptcy

By Fred Schmalz

Last month, U.S. Bankruptcy Judge Steven Rhodes announced an agreement wherein the City of Detroit would exit bankruptcy protection. There was much relief and rejoicing around the Motor City. In what might be considered the end of the beginning of the struggle to right the city’s books and guide it into the future, Detroit had flown through a process that has become protracted, contentious, and messy in other cities—think Stockton, Vallejo, and San Bernadino, California, and Jefferson County, Alabama.

Detroit’s emergence with a long-term plan to pay off creditors, salvage pensions, and preserve the Detroit Institute of Arts’ permanent collection has a lot of people feeling hopeful about the city’s future, not least Don Haider, a professor of strategy at the Kellogg School and one of the people involved in the bailout of New York City in the 1970s while serving at the U.S. Treasury Department.

The bankruptcy process happened in fewer than 16 months—much faster than anyone had anticipated given the legal complexities and the fact that the city was negotiating with more than 100,000 creditors and $18 billion in debt. With reorganization behind it, Detroit now faces a monumental rebuild with a lot of uncertainty.

“The parts are coming together,” Haider says. “Detroit has a viable, feasible plan that has been vetted by dozens of people and will be tweaked along the way; it has promising civic infrastructure and support; they got in and out of bankruptcy at incredible speed; and Michigan’s economy has done well.”

How did Detroit thread the needle on its bankruptcy? Insightreported on the story as it unfolded. Haider chalks the successes of the reboot up to two things: law and leadership.

“Michigan has emergency powers for the state to place local governments into receivership,” Haider says, “so the state has the authority to exercise its oversight over Detroit. They followed the legal precedents that came out of New York in the 1970s, which helped. Judge Rhodes ruled that federal bankruptcy law trumps state law protecting pensions and contracts. This was critical to the resolution.”

“The leadership personalities involved—in public and private [sectors], in federal, state, local [governments], in foundations, in the business community—are really one of the lessons of Detroit’s getting through this as quickly as they have,” Haider says. “It was ‘all hands on deck.’ Everybody pulled together with a single objective: we’re going to get Detroit out of bankruptcy with a viable plan. We’re starting a journey, not ending it.”

“It’s not like a corporation, where you just dissolve all the assets and everyone goes home and that’s the end of the corporation,” Haider says. “There is a governance issue—the city has to go on.”

After the largest municipal bankruptcy in the history of the United States, Haider thinks the city will go on with a fighting chance.

Gauging the Magnitude of Repair

“Detroit is a laboratory by necessity. I think you see the promising building blocks of what Detroit aspires to do,” Haider says. “They’re carving out, block-by-block, a new middle class: a lot of start-ups and small businesses, a lot of young people that want to make Detroit. ”

The city’s bottoming out has given Detroit the opportunity to redefine itself as a model for the 21st Century American city. With the right amount of will and investment, the city can promote interesting spatial design and architecture, from urban farming to tech corridors.

The recovery plan sets aside $1.3 billion for recycling properties and improving public services. Is that enough? Is it too little? At the moment, Haider says, it is too early to tell.

“The magnitude of the repair can only be guessed at, but investment is growing downtown,” Haider says. “New manufacturing investment in 21st Century design, nanotechnology, new metallurgy, support from the auto industry and its suppliers. You’re starting to see incubators, with local colleges and universities in support.”

Haider notes signs of life on the revenue side as well: Detroit still has gaming revenues from its casinos. Property values may have bottomed out since Quicken Loans bought up chunks of downtown real estate and started migrating its 12,000 employees from the suburbs. More property will go back on the tax rolls.

Setting up for Success

“If you try to return control to the same people that got you in trouble in the first place, you’re going to have to ask some serious problems,” Haider says. “As you return democracy to a local government, you’ve got to have some oversight. And that’s what the state has done.”

A government-appointed financial review commission has been put in place to act as a control board over the execution of the plan for the next decade. This commission will provide oversight of the city’s and the pension funds’ finances and budgets and have veto power over the mayor and city council.

So whether this is the beginning of the end or the end of the beginning of Detroit is uncertain, but there is a new transparency to the post-bankruptcy process. “New pension rules, new disclosure rules, new oversight board, budgets that are clearly vetted publically—there should be little ambiguity going forward about where Detroit is, whether they’re making progress or not making progress,” Haider says.

“It has nowhere to go but up, but you have the semblance of a possibility. It’s promising.”

Learning from Detroit

Haider sees ways in which other struggling municipalities can learn from Detroit’s experience: from fixing outdated tax collection systems, to full disclosure of the costs of government, including pension and public employee retirement plans, to improved infrastructure and services including streetlights and light rail, to letting the city’s residents take on parts of the rebuilding task.

“Detroit’s new leaders are looking at every component of the city to see what services can be privatized, contracted out, shared, localized, or taken over by neighborhoods,” Haider says. “Given high unemployment rate in the city, asking what can be done to employ, engage, and involve people, to make them stakeholders and to keep resources local, is something that every city is going to learn from.”

Editor's Note: Don Haider is a clinical professor of strategy at the Kellogg School of Management, Northwestern University.Photo credit belongs to Jason Mrachina. Published under a Creative Commons license.